Timing the adoption of a new technology: an option-based approach.

Because of its recurrent role in influencing the strategic alternatives open to competing firms, technology is one of the main forces which operates in the business arena. Certainly, technology is a formidable strategic weapon which deeply affects the nature of the five competitive forces, and pervades the whole firm's value chain[1], far beyond those techniques directly associated with the manufacturing process. As a consequence of the more important role ascribed to technology in business strategy, in recent years strategic management of technology has emerged as a distinctive managerial field[2]. It is concerned with how the firm might use technology to get a sound competitive basis[3], or in other words how technology has to be integrated throughout the organization as a source of competitive advantage[4]. In this perspective, companies are requested to link technology to corporate strategy; the resulting technology strategy is a plan which guides firms' decisions on technology identification, development, acquisition and application[5].

An effective and proactive strategic management of technology involves various decisions: from the formulation of a global technology plan to the selection and the adoption of a specific new asset. The basic question regarding the latter concerns which new technology has to be adopted and when. Time, in particular, is a crucial point, and deciding on the appropriate time is a critical issue[6] which raises substantial questions coming from: the intrinsic uncertainty surrounding each new technology; the inherently intangible nature of many of the expected benefits; the long-term perspective involved by a technological commitment; the current and future availability of technical and economic information about the new technology; the need to develop new competences and skills; the role played by learning processes; the partial or complete irreversibility of the innovative investment.

Since traditional capital budgeting techniques tend to ignore all these questions, they do not seem to be of particular help in deciding on the adoption time. Recently, however, a valuation approach which tries to overcome these limitations has emerged from the theory of financial option pricing. The resulting real option approach seems to provide a powerful tool for the assessment of technology investments because it allows one to account for irreversibility and uncertainty, and explicitly recognizes that time affects the investment returns.

The aim of this paper is to provide a procedure for timing technology investments which is based on the option theory. According to this procedure, the decision to invest is treated as the decision to exercise a financial option. In this sense, the new investment is evaluated on the basis of the present and future opportunities it discloses and the adoption decision is taken when one can most profit from all the embedded options.

The real option approach to investment

The use of conventional capital budgeting techniques and, in particular, the discounted cash flow (DCF) analysis in evaluating innovative projects has been widely criticized. In particular, the opinion has recently spread that, when innovative investments are concerned, traditional procedures may understate their true economic value and hence induce the firm not to pursue them[7-9]. This not being the place to recall all the criticisms, we will limit ourselves to remembering that the conventional investment analysis ignores:

* the strategic growth opportunities connected with the new investment;

* the fact that the project can be discontinued before the end of its economic life;

* the possibility of delaying the investment decision;

* the arrival of information throughout the project life;

* the option temporarily to stop its execution[10].

More specifically, traditional analysis generally treats investments as isolated opportunities about which decisions must be made immediately[1] and encourages concentration on the individual decision[12]; also, having a systematic bias towards the short term, it fails to evaluate the long-term and strategic factors involved in innovative investments[8]. In short, what is important to our aims is that within this framework time is not a matter of choice, given that the investment is viewed as a now or never decision.

Highlighting some shortcomings of the traditional approach, in 1984 Kester[13] used the term "growth options" to denote future opportunities that (in his opinion) each investment project unfailingly carries out. Afterwards, the option concept was enriched and more often suggested for issues such as uncertainty and flexibility, where the …